One Reason the Rich Get Richer: Accredited Investors

There’s been a lot of focus on the 1% over the past few years, with the unemployment rates still high and wealth growth only stable across the richest individuals in the world. One of the most cited reasons why the rich get richer are all the tax loopholes, and these, indeed, help millionaires and billionaires get richer. But one thing that isn’t talked about a lot is “accredited investor” status.

a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person

a natural person with income exceeding $200,000 in each of the two most recent yearsor joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year

In other words, accredited investors are the 1%. If you’re not already in the 1%, this rule makes it harder to get there. For people who took risks early in life, built companies from the ground up, and became millionaires from their own hard work, this is all fine and dandy – they clearly deserve the privileges availed to accredited investors. However, many with this status have $1M+ bank accounts thanks to mom, dad, grandpa and grandma. And as long as accredited investor status exists, the wealth chasm between the rich and the poor will continue to grow.

I recently worked for a startup that was sold to a large company that has since went public. While I did not own a large number of stock options (2000), I was not eligible to transfer my shares to shares of the acquiring company because I was not an accredited investor. Instead, I had to sell my shares for $3 a share, netting a profit of $5k. This was a nice bonus, for sure, but had I been able to convert my handful of shares into the now-public companies shares, I would have netted approximately $52k.

The idea being accredited investors is that you should have a large cushion of money to take on high risk investment opportunities. In this case, it was very clear that the risk in converting my 2000 shares to 2000 shares of the acquiring company’s stock would have not been high risk, but it kept me from making this conversion.

In the case of my prior company, I am not upset about this since the company was ultimately acquired for its technical resources, and I was not one of these resources, but it is still a little disconcerting that in a company of 10 full time employees, where more than half are millionaires, the rest of employees do not have access to the same wealth. This is more concerning in my current situation where I traded in a somewhat cushy six figure salary for a job with many more stock options. Should a similar situation happen again upon an acquisition, there would be greater cause for upset.

Beyond this specific instance, there are many other reasons why accredited investor status helps the wealthy get richer. Accredited investors gain access to a variety of investments that, while risky, are often not that much riskier than the investments that one can make in the traditional stock market, and, more importantly, they have a much higher growth potential.

As with any investment, diversification is key to success, so if you’re not a millionaire it might be difficult to properly diversify. This is the only reason I understand the rule and find it remotely fair, but again, there are many high-risk investments that aren’t limited to the wealthy… it’s just the high-risk investments that have high-return potential that are limited.

If you fit into this category you may be eligible for many investment opportunities such as hedge funds, commodity funds and special public funds that other investors are not allowed to participate in.

The key is that many higher risk, and thus higher reward, investments are only available to qualified “accredited investors.”

The main benefit to qualifying is that you gain access to investments, and greater returns, that “average” investors can not access.

Quite simply, it comes down to convenience and privacy for the investment managers. By marketing securities only to accredited investors, a fund or company can avoid many of the filing requirements to which most public companies are subjected.

One benefit of being an accredited investor is being able to be an “Angel” investor in a very early stage company. This is indeed one of the riskier investments, thus not something I’d recommend to a person who has a networth under $1M. Some famous investors such as Ron Conway and Paul Graham are well diversified, having made 190 and 129 angel investments, respectively.

Angel investments can range quite vastly — the typical investment of an angel investor ranges from $10,000 to $250,000; however, they are known for investing up to $1.5 million dollars in any given venture, according to Go4Funding. To invest in 100 companies for $10k each, that is $1M, thus making the $1M accredited investor rule make a little bit of sense. Still, I believe that the government should not be able to tell you if an investment is too high risk for your portfolio. If I want to invest $10k of my personal funds into a startup that I think has a lot of potential for growth, I should be allowed to do this. In reality, I had to pay $20,000 to “buy” my stock options of the private company that I work for, but I would not be allowed to invest in a company that I do not work for because I only have $150k in assets.

Meanwhile, there are other investment opportunities open to accredited investors that are less risky than angel investing. For example, let’s take a look at Second Market. Second Market is a company that helps owners of private stock sell their stock before the company goes public. So, for instance, an accredited investor could purchase shares of Facebook stock before it goes public for a price which she believes will be substantially lower than the price it will go public for. The investment is risky — a private company may never go public despite its success, and it is not clear on what the price will be when it hits the market even if it does — but ultimately most of these investments in big, fast-growth private companies net investors serious growth.

According to SecondMarket, “For regulatory reasons, in order to view listings and place indicative bids on securities through SecondMarket, you must be an Accredited Investor or Qualified Institutional Buyer (“QIB”). However, you do not have to be an Accredited Investor or QIB to list your assets for sale.”

In short, this is one major reason why the rich get richer, and the rest of us are unable to access the same investment opportunities available to the 1%.

I’m not alone in this outrage. There is a movement afoot to allow the 99% to invest in startups. A law is currently in Congress that would allow the rest of us to invest up to $1,000 in private companies. While I believe that the government should not be able to limit investments to $1,000, it is a start. Please do your part and sign this petition to support crowd funding. It is a small step in the right direction.

6 comments

I like the accredited investor rule. Although some “poor” people may have the knowledge and money to make these investments, the majority do not.
Don’t blame the rich for this rule. Blame the poor people who don’t know how to handle their money; someone or something has to protect those people.

I am in a similar situation. I worked for a small think tank lab dealing with petro-chemicals. the engineers paid expenses out of pocket (materials, lights, phone, and my wages). It was clear that the budget was tight so i offered to discount my labor for a slice of ownership. Now that the product i helped develop is getting close to becoming a multi-million dollar process/product they are saying i am not an accredited investor and i cannot be an "owner". ANY ideas how to keep my slice of the pie?

Great info, thanks for sharing all that. I definitely support crowed investing. Everyone should be given equal opportunity to become successful. Hey, maybe some day we'll both become accredited investors.

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The anti-minimalist: I'm the absolute worst with money. I have a shopping addiction. That's exactly why this blog exists. HECC is not a typical personal finance blog. I started it in 2007 to hold myself accountable for binge spending, a dropping networth, and lack of overall fiscal literacy. 10 years later, had achieved a networth of over $500k. Now my goal is to hit $1M by 40. Recently married and with my first kid on the way, things are about to get... interesting. I write about the intersection of mental health and money, spending & investing, and millennial personal finance.